What impact does government regulation have on the financial services sector?

Government regulation affects the financial services industry in many ways, but the specific impact depends on the nature of the regulation. Increased regulation typically means a higher workload for people in financial services, because it takes time and effort to adapt business practices that follow the new regulations correctly.

While the increased time and workload resulting from government regulation can be detrimental to individual financial or credit services companies in the short term, government regulations can also benefit the financial services industry as a whole in the long term. The Sarbanes-Oxley Act was passed by Congress in 2002 in response to multiple financial scandals involving large conglomerates such as Enron and WorldCom. The act held senior management of companies accountable for the accuracy of their financial statements, while also requiring that internal controls be established at these companies to prevent future fraud and abuse. Implementing these regulations was expensive, but the act gave more protection to people investing in financial services, which can increase investor confidence and improve overall corporate investment.

Other Types of Regulations That Affect the Financial Services Industry

The Securities and Exchange Commission (SEC) regulates the securities markets and is supposed to protect investors against mismanagement and fraud. Ideally, these types of regulations also encourage more investment, and help protect the stability of financial services companies. This does not always work, as the financial crisis of 2007 demonstrated. The SEC had relaxed the net capital requirement for major investment banks, allowing them to carry significantly more debt than what they had in equity. When the housing bubble imploded, the excess debt became toxic and banks started to fail.

Other types of regulation do not benefit financial services or asset management at all, but are intended to protect other interests outside of the corporate world. Environmental regulations are a common example of this. The Environmental Protection Agency (EPA) often requires a company or industry to upgrade equipment and to use more expensive processes to reduce environmental impact. These types of regulations often have a ripple effect, causing tumult in the stock market and overall instability in the financial sector as the regulations take effect. Companies often try to shift their increased costs to their consumers or customers, which is another reason why environmental regulations are often controversial.

Government regulation has also been used in the past to save businesses that would otherwise not survive. The Troubled Asset Relief Program was run by the United States Treasury and gave it the authority to inject billions of dollars into the U.S. financial system to stabilize it in the wake of the 2007 and 2008 financial crisis. This type of government intervention is typically frowned upon in the U.S., but the extreme nature of the crisis required quick and strong action to prevent a complete financial collapse.

The Government as Moderator

The government plays the role of moderator between brokerage firms and consumers. Too much regulation can stifle innovation and drive up costs, while too little can lead to mismanagement, corruption and collapse. This makes it difficult to determine the exact impact government regulation will have in the financial services sector, but that impact is typically far-reaching and long-lasting. (For related reading, see: Government Regulations: Do They Help Businesses?)